Audit Firms: Figure This Out!

Above: Satyam, the company owned by Ramalinga Raju, fudged cash and bank balances

With increasing corporate misdemeanour and the government under pressure to tighten the screws on auditors, many are withdrawing from auditing the accounts of clients

~By Kingshuk Nag in Hyderabad

Winds of change are blowing over the Indian corporate sector and, curiously enough, at the receiving end are statutory auditors of companies. With indifferent corporate governance for decades, many auditors have looked the other way while going through the books of account of companies. But now this is coming to an end, thanks to stricter governmental norms. This, of course, reflects the growing public concerns of investors who don’t know where their money has been disappearing.

In the last few months, top audit firms like PricewaterhouseCoopers (PwC) and Deloitte Haskins & Sells resigned as auditors of some companies primarily because of their clients not revealing adequate information about their transactions. In fact, data reveals that auditors of 204 listed companies quit their assignments in the last few months because of their clients’ inability to disclose full information about businesses and deals. However, most of the companies that auditors exited are virtually unknown names.

So what’s wrong? Though it would seem so, the abrupt exit of auditors does not reflect a sudden increase in wrongdoing in India’s corporate sector. Rather, it is a manifestation of the screws being tightened by the government in recent times. For long, there has been a camaraderie between the top management of firms and their auditors that has reflected in balance sheets of corporates not being properly audited. Even as auditors’ fees have gone up (in some cases mirroring the nexus between them and the company management), shareholders have been left high and dry without proper information coming their way.

The most startling evidence of lack of proper auditing came to light in the Satyam scam in 2009. The then chairman of Satyam, Ramalinga Raju, in a letter to the Bombay Stock Exchange (BSE) confessed to the stock markets that his company had been fudging income, but funnily enough the auditors failed to detect this in any of their audit reports! Raju and the auditors were sentenced to jail but the episode brought to light the failings of the auditors—PwC in that case.

In January 2018—over nine years after the Satyam scam broke out—the company’s auditors, PwC, were handed a two-year ban by SEBI. PwC could not take up audit assignments from April 1, 2018. PwC has 11 network firms that employ 2,500 people in India.

Post the Satyam case, the government has been under pressure to put auditors under tighter control. Under the new Companies Act, 2013, there are strict duties and responsibilities for auditors, including reporting fraud. Moreover, it is binding on auditors to pay damages to shareholders and statutory bodies for loss arising out of incorrect and misleading reports.

With these strict laws in place, the auditors have become chastened and the PwC ban will make them more prudent. The reasons cited by the auditors for resigning from the 204 companies they were auditing were manifold. They included lack of adequate information on business, inconsistencies in revenues and financial numbers as also complaints received from investors and other stakeholders. Incidentally, under the new provisions, the auditors have to file a report (on a specified e-form) to the government stating the exact reasons for which they are quitting their assignment.

In May 2017, the ministry of company affairs (MoCA) enacted a change in the Companies Act whereby the entire audit firm is held responsible for the misdeeds of a single partner. This is a departure from the past where the liability devolved on the actual people involved in the auditing. Reports in newspapers suggest that within weeks, auditors dropped companies that they were evaluating.

According to information collected by research agency Prime Data Base, in 2017-18, 37 auditors withdrew from auditing the accounts of their clients. This figure is a sharp climb from previous years. There were only six cases in 2012-13, 11 in 2013-14, 11 in 2014-15, 15 in 2015-16 and 18 in 2016-17. In some cases, the withdrawal of the auditors came only days before the finalisation of accounts—thereby implying that a prolonged tussle had been on between the auditors and the company management for “adequate information”.

The stricter government norms have put a brake on big audit firms and their earnings. A report in The Economic Times (June 15) suggests that the bigger audit firms are removing/relaxing revenue targets for their audit partners. As per the earlier norms, an audit partner (with 10-12 professionals working with him) would bag a project and he would normally get 20-35 percent of the revenue earned as compensation. “With their compensations tied up like this, there was a virtual race to acquire new clients and do their audits in some way. In the process, some of the drawbacks in the books of account were also overlooked,” confesses a senior chartered accountant who does not want to be identified. This means that the audit firms focused on maximising their revenues and not necessarily on auditing in the best possible manner and with due diligence.

With increasing corporate misdemeanour in this permissive regime, the government has been under pressure to step up the regulatory regime for auditors. This became stronger after the Kingfisher scam when company promoter Vijay Mallya fled to the UK and is still holed up there even as the Indian government is making frenetic attempts to get him extradited.

Prime Minister Narendra Modi who does not want his government’s image to be impacted by “goings-on” which he avers are “fallouts” of the previous regimes, is unhappy with the auditors. In a direct interaction with auditors for the first time under the auspices of the Institute of Chartered Accountants of India on July 1, 2017, he asked them to be careful in their jobs, because pensioners and widows depend on audit reports to decide where to park their funds. “A CA’s signature is more powerful than that of a prime minister. Your signature carries immense faith. Please do not break the trust placed in you. You have been given immense powers by Parliament,” he said.

Almost simultaneously, the government set up a committee under market man Uday Kotak in July 2017 to improve standards relating to corporate governance, including accounting and auditing practices of listed companies. The Kotak report was partly adopted by the board of Securities and Exchange Board of India (SEBI) at the end of February 2018 and this included disclosure of the credentials of auditors, the audit fee and reasons for resignation of auditors if they quit. “The move improves corporate governance and also brings accountability for auditors who were having a relatively free run till now,” said a leading chartered accountant who did not want to be named.

In the meanwhile, even as he wields the stick on audit firms, Modi has decided to introduce a new sense of competitiveness amongst auditors. The prime minister said at a meeting with chartered accountants that there are the Big 4 audit firms in the country which are all foreign-owned (PwC, Ernst & Young, Deloitte and KPMG). “By 2022, I would wish to see a Big 8 of which 4 are Indian auditors,” he said, much to the delight of Indian firms.

The announcement has brought in a wave of excitement among Indian firms. Edged out of lucrative contracts in the last two-and-a-half decades which saw the entry of foreign auditors and their Indian subsidiaries (like PwC which is a foreign audit firm with a local branch), Indian firms that ruled the roost hope that the field will now become loaded in their favour. Time alone will tell whe­ther this will happen.